Why is Indexed Universal Life Insurance (IUL) a Good Idea for Retirement Savings?

Thang Truong
Thang Truong
Updated on:

The Indexed Universal Life (IUL) insurance policy offers the best of both a retirement income and an inheritance for loved ones after death. It is a unique kind of permanent insurance policy designed with an initial death benefit and a separate cash value that is tied to the annual performance of an index, like the S&P 500. 

If the index does well the cash-value increases at a preset rate up to a maximum cap, usually 12%. If the index shrinks the cash value is protected by a crediting floor of 0% to 2%, depending on the company and the product, so you don’t actually lose any money. This is possible because the IUL isn’t invested in the stock market. The insurance company simply uses the index’s performance to determine annual growth rate.

>>MORE: Should I Invest in S&P 500 Index Through an Indexed Universal Life Insurance (IUL) Policy?

With high annual interest rates your IUL’s cash value could become a good source of retirement funds by the time you need it in 20 or 30 years. Although, insurance policies aren’t typically seen as investment options. You may also be considering a financial product designed to grow retirement income. These other products are directly invested in the stock market, which means greater risk, but potentially higher rewards. Before you invest in an IUL or a retirement account, it pays to learn about both options.

IUL or Savings Accounts: Which is Better for Retirement Savings?

Savings accounts are available at any bank or credit union and allow people to set aside as much money as they like in any quantity or frequency. This is a good option if you want lots of flexibility in how much you set aside and how often. Here is a quick run-down of the benefits of a savings account:

  • Money you place in a bank is protected by the FDIC up to $250,000. 
  • Interest is earned on most savings accounts but can be low. Current rates are between .25% to 1.5%. You are required to pay marginal income tax on the interests you earn on a savings account on annual basis.
  • Account holders can access this money easily by going to the bank or even a debit card.

An IUL may not be covered by FDIC insurance, but it is covered by state-sanctioned Insurance Guaranty Associations. These associations step in should your insurance company become insolvent. They will either pay your policy at the state’s set coverage, usually $300,000 maximum death benefits and $100,000 maximum cash surrenders.

The Indexed Universal Life Insurance (IUL) also grows your cash value at a much higher rate than a savings account, up to 12% based on the index market. Though, this can vary. 

Lastly, you can access the cash value in your policy by withdrawing it or you can take out a loan against the policy when needed. The biggest benefit of an IUL policy is that when you withdraw or take out a loan from the policy, you do not pay any income tax. The money you get from the policy is all yours and yours only.

>>MORE: Tax Benefits of Life Insurance: Compare with Other Retirement and Investment Options

IUL or Investment Accounts: Which is Better for Retirement Savings?

An investment account is available through a licensed brokerage firm, like Charles Schwab, TD AmeriTrade, or E*Trade. These accounts allow you to invest in any number of ways, such as purchasing:

  • Stocks
  • Bonds
  • Mutual Fund Shares
  • Real Estate
  • Cryptocurrency

They are very flexible in what you can invest in compared to an Indexed Universal Life Insurance (IUL) that is only tied to the performance of the index market. There are no limits on how much you can invest in a year, which is a potential problem with IULs. Life insurers only allow you to invest up to the 7 Pay Limit which restricts how much your premium payments can be for the first seven years of your policy. 

It’s also possible to sell your investments at any time and take cash out of the account. However, you may pay higher fees to manage the investment account and when selling investments. A typical fee for taking out a loan against your IUL is about $25. You’ll also end up paying capital gains taxes on your profits from the investment account.

On the downside, you will have to pay tax on the interest and gains on your investments. They can be short term or long term capital gain tax. Long term if you hold the investments more than a year before you sell. On the other hand, withdrawing from an IUL policy to supplement retirement income is completely tax income. The money from an IUL policy is all yours.

>>MORE: Compare Whole Life Insurance with Indexed Universal Life Insurance

IUL or IRAs: Which is Better for Retirement Savings?

The IRA is a common type of investment account that is specially designed to provide retirement income in your senior years. There are multiple IRAs that you may qualify for depending on your employment status, such as a traditional IRA that offers an upfront tax deduction on the money you deposit or a Roth IRA that offers tax-free withdrawals. IRAs have key features to be aware of before you invest in one:

  • Annual contributions are limited; usually to $6,000
  • Employers may match contributions up to 50%
  • Tax deductions and contributions are limited by your income
  • Cash withdrawals made before 59.5 years old are penalized with fees and income tax
  • Cash withdrawals made after 59.5 are taxable
  • Account holders must begin making withdrawals at 72 years old
  • No crediting floor is in place so you can lose money on investments

IULs also limit contributions based on the 7 Pay Limit mentioned previously. However, account holders can take loans or withdrawals out of the cash-value of their IULs at any time with just a small fee and completely tax free. If you feel like you’ll need to access your money before the age of 59.5 and don’t want to pay tax on the investment gain of your money, the IRA might not be your best bet.

>>MORE: Is Life Insurance Tax Deductible?

IUL or 401Ks: Which is Better for Retirement Savings?

The original retirement account for the average person, a 401K is primarily offered through employers. This can be a drawback if you are a business owner or a sole proprietor. Companies offering 401Ks usually match 50% the contribution their employees make to each account up to the yearly maximum. The 401K has a $19,500 yearly contribution limit.

Finally, the 401K allows account holders to deduct their contributions from their yearly income. This helps reduce annual taxes on your income. For instance, if an employee earning $60,000 puts $19,500 into their 401K they would only be taxed on $40,500 income. However, when you withdraw from your 401K in retirement years, you have to pay 100% income tax on the withdrawal amount.

The IUL offers more flexibility than the 401K:

  • There is no limit on contributions as long as you purchase enough insurance to cover the 7 Pay Rule. 
  • The IUL is available to anyone regardless of whether they work, don’t work, or have a small business.
  • The IUL offers 100% tax-free withdrawals later in retirement

>>MORE: A Guide to Understand How Retirement Income is Taxed

IUL or Roth IRA Accounts: Which is Better for Retirement Savings?

Another type of investment account you might want to consider is the Roth IRA. This is not available to those who earn more than $139,000 per year ($206,000 for couples). There are no taxes on qualified withdrawals from the Roth IRA in retirement. On the downside, the contribution limit is just $6,000 per year on the Roth IRA and the Traditional IRA combined.  

How does this compare to an IUL?

Again, an IUL allows policy holders to invest as much as they like providing they don’t run afoul of the 7 Pay Rule. Otherwise, the Roth IRA is similar to the IUL in the tax-free withdrawal advantage. Roth IRA is still an investment account that is directly exposed to the market. You are at risk of losing money in the stock market if your investments do not perform well. However, an IUL usually has a crediting floor of zero or one percent that really prevents those potential losses.

>>MORE: Case Studies of Different Types of Universal Life Insurance

Final Thoughts

  • The IUL is a good option because it provides a combination of permanent life insurance and tax-free retirement savings.
  • IULs grow cash-value by tying it to the performance of an index, like the S&P 500.
  • Other investment accounts aren’t designed to be life insurance, but can be inherited.
  • Savings accounts offer the most flexibility with no contribution limits, no income limits, and no fees for withdrawals.
  • Investment accounts provide retirement income with tax benefits on either contributions or withdrawals.
  • Investment accounts may offer the greatest growth rates, but also higher risk with direct exposure to the stock market.
Thang Truong

Thang Truong covers small business insurance and small business success at BravoPolicy. He is a licensed P&C insurance agent. Previously, he held product leadership positions at realtor.com, Capital One, NerdWallet, and Mulberry Technology. He holds a MBA degree from UC Berkeley - Haas School of Business.

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